If you’re a public school teacher or government official, you ay contribute to a 457b plan (also known as a 457). Now more than ever so many Americans have a part-time job on the side, working evenings and weekends. If this is the case for you, you might also qualify for a Solo 401k. So, can you contribute to both a 457b and Solo 401k at the same time?
The short answer is Yes, you can contribute to both a 457b and a Solo 401k. The longer answer is that you do need to qualify for this significant tax advantage status. We’ve shared how you can maximize your retirement savings and tax deferrals by contributing to both an employer 401k and your Solo 401k. This is another version that includes a 457b retirement plan. When combined with a Solo 401k it can be even more beneficial to your total retirement strategy.
What’s the Difference Between a 457b and Solo 401k?
The 457b and Solo 401k have a lot in common. Especially when it comes to tax favorable treatment. However, one of the most important attributes is that the IRS has determined it is absolutely fine to contribute to both a 457b and Solo 401k during the same tax year.
“The amount you can defer (including pre-tax and Roth contributions) to all your plans (not including 457(b) plans) is $19,500 in 2020 and in 2021…. If you’re in a 457(b) plan, you have a separate limit that includes both employee and employer contributions.”
~ IRS – If You’re Eligible for More than One Retirement Plan
Also very important is that a 457b has a few attributes that are different from a Solo 401k. When you know these, you can make this work in your favor. Let’s begin with the fact that the two accounts are regulated by two different sets of tax law. The Solo 401k is a qualified retirement plan covered by the Employee Retirement Income Security Act of 1974 (ERISA). The 457b is a non-qualified retirement plan that doesn’t come with the same rules as qualified plans. The combination of contributing to both a 401k and a 457b retirement plan can allow you to double your tax-deferred savings and reduce your taxable income.
Who Can Have a 457 Retirement Plan?
A Solo 401k is available to you as an employee of your business. A 457b is primarily offered by state and local governments to their employees. Government employees typically include:
- Government officials at the state or local levels
- Public school teachers
- County and city employees
- Law enforcement personnel and first responders
- Other government employees
- Some nonprofit employers can offer these plans as well
There are chiefly two attributes to the 457b that are different from a 401k. First, employer-matching contributions are relatively uncommon with 457b plans. If an employer makes a matching contribution, those contributions plus the employee’s can’t exceed the total annual contribution limit. Second, 457b accounts allow for special catch-up contributions for workers three years away from the normal retirement age. Those employees can contribute the lesser of twice the annual contribution limit or the regular annual limit, plus the amount of the annual contribution limit not used in prior years. The latter is allowed only if the employee isn’t using the standard 50-or-older catch-up contributions. The IRS provides this chart comparing a 457b to a 401k.
You can rollover a 457b to your Solo 401k if your employer allows it or when you no longer work for that employer. The first step is setting up a Solo 401k to roll the 457 into.
Contribute to a 457b and Solo 401k
Because you can contribute to both plans during the same year, you need to know the contribution limits of both to maximize your tax-deferred contributions.
Solo 401k contribution limits. The IRS again raised the limit for 2021. The defined contribution limit for 2021 is $58,000 (up from $57,000 in 2020). If you’re age 50 or over, the total contribution limit is $64,500. When your spouse also participates in a Solo 401k, the potential contribution limit doubles to $129,000! Use the Solo 401k Retirement Calculator to help determine the future potential value of your Solo 401k account.
457b contribution Limits. The IRS limits in 2021 allow you to defer the lesser of $19,500 or 100% of your compensation to a 457b plan. The plan may also permit catch-up contributions.
Catch-up deferrals. A governmental 457b plan may allow age-50 catch-ups of an additional $6,500 in 2021 (total deferral becomes $26,000). There is also a Special Catch-up contribution, if permitted by the plan. It allows a participant for 3 years before the normal retirement age (as specified in the plan) to contribute the lesser of:
- Twice the annual limit (totaling $39,000 in 2021) -or-
- The basic annual limit plus the amount of the basic limit not used in prior years (only allowed if not using age 50 or over catch-up contributions).
Pros and Cons of a 457b
There may (or may not) be a few special perks to the 457b plan. For one, the catchup clause for a 457b can begin three years before the “normal retirement age.” The “normal retirement age” is defined by the specific plan and can vary between plans. In comparison, a 401k plan is very clear that catchup contributions can only begin at age 50.
Another is that because a 457b is a non-qualified plan, it is not subject to the same withdrawal rules as a 401k. You can take money from your account at any time. Withdrawals before or after retirement don’t trigger a penalty based on age. However, you will pay regular income tax on those withdrawals, unless you have a designated Roth account.
On the downside, 457b plans often charge higher administrative and management fees than other retirement plans. Also, you’ll have a limited range of investment options to choose from within the plan. The Solo 401k cannot be beaten for diversifying your investment portfolio. Another downside is employer contributions are much more common with a 401k than with a 457b.
How to Maximize Benefits of Both Plans
You can have access to a 457b and start a Solo 401k that will supercharge your retirement savings. The IRS says it’s okay to contribute to both at the same time. Because contribution limits of either one do not count towards the other, contributing to both can double your tax savings and deferral.
But in which order you should fund your accounts? First, compare employer contributions to maximize your savings and tax deferrals. It’s quite possible a 457b does not have matching contributions and if it does, it will almost certainly be lower than what you can maximize with a Solo 401k. On the other hand, if you’re not yet 50 and can make catch-up contributions to a 457b that might make sense. Also, if you’re not 59 ½ but anticipate needing to make a withdrawal, the 457b does not impose the early withdrawal penalty.
Another option to strongly consider is rolling over a 457b into a Solo 401k as soon as possible to obtain all of the diverse investment options available with a Solo 401k.
Bottom Line. Both a 457b and a Solo 401k can help you grow retirement savings for the long term. Understanding how both plans work helps you make the most of your contributions during your working years.
